In my column last week, I tried to equip you to understand the cycle of emotions and the reasons why some investors find it difficult to remain disciplined in times of volatility. I continue this week by giving you the secrets of the rational investor.
Stay calm. Historical analysis shows that periods of volatility are not only temporary, but also normal. Moreover, they are sometimes advantageous for those who maintain or increase their investments in risky assets in periods of turmoil. The rational investor keeps his eyes on the medium and long term, which allows him to avoid irrational actions. Of course, sometimes that seems easier said than done! Based on the facts, you could, for example, keep in mind that, despite average annual declines of 13.9% between 1980 and 2018, the S&P 500 ended the year with a positive return on 29 of those 39 years.
be patient. In the event of a market decline, the watchword is “patience”. In the stock market, you will almost always be rewarded with a long-term view of the markets. Thus, the analysis of a fund or an index over a long period can present an attractive annualized return. However, if you subtract the 10, 20 or 30 worst days, the long-term return of this fund decreases significantly and will even become negative in some cases. In short, since he can neither afford to miss the best days nor guess precisely when the markets will begin to rise, the investor must be patient and not take his losses.
Choosing the “right time” to invest. When you’re thinking of selling everything, tell yourself it’s time to buy; volatility does not mean return opportunities are gone. Historically, each year has seen events that have resulted in volatility and significant declines in the markets (eg the Gulf crisis in 1990, the tech bubble in 2000, the recession of 2008-2009). Most of these events, however, had only a short-term impact on the markets, and the rational investor benefited from them in the long term…
Stay invested. If you are considering replacing your investments with cash, it is important to understand that you will subject your portfolio to other risks. While this may seem safe, even at a modest 2% inflation rate, the rational investor understands that they will lose 10% of their purchasing power over a five-year period. Inflation seriously threatens your long-term plan, but only in less apparent ways. Before making such a decision, ask yourself instead what you can do to avoid the urge to withdraw from the markets in the future.
Stop constantly reviewing your investments. Do you have the obsessive habit of daily checking where your wallet is? Market volatility is generally higher over short periods. Consequently, the fluctuations in the value of your investments will seem all the more important to you if you follow them every day. The rational investor reviews monthly, quarterly or even annually, and is thus more likely to detect long-term trends.
Prioritize periodic purchase. In periods of volatility, the market spreads observed each day influence the average acquisition cost of your securities. If you have a large amount to invest, it would probably be wiser to favor periodic purchases. For example, if you invest 100% of your capital today in a single purchase, you will potentially have fewer units invested than if the average annual cost of these units is lower. The rational investor understands that this strategy is particularly important when the investment horizon is short.
Log out once in a while. Share prices are available in real time and any ups and downs in the market are the subject of a continuous news feed. It is only natural that alarmist and pessimist headlines increase your nervousness… and the risk that you will react with emotional transactions! The rational investor knows that he should not base his investment decisions on the headlines or what is published by his contacts on social media.